Multifamily oversupply becoming a concern

Demand seems strong, but construction of 260,000 units will start this year in the U.S. -- is it just too much?

By JOE GOSE, The New York Times

Over the last year, apartment eveloper Arnie Gregory has opened 236 rentals in downtown Minneapolis' trendy North Loop neighborhood. All are full and fetching rents higher than expected.

But a 171-unit project set to open later this year south of downtown may be his last for a while, amid growing unease that apartment construction may outpace demand.

"There is a lot of product being delivered in the next 12 months," said Gregory, owner of real estate development firm Greco. "A lot. I'm always worried about being the last one at the trough."

Driven by surging apartment demand and an average vacancy rate of a scant 2.3 percent, more than 7,000 units are being built and 13,600 more have been proposed in the Twin Cities alone, according to Nicolett Partners Advisors, a Minneapolis appraiser.

The same is true, on a different scale, in Southwest Florida, as developers have sought to fill a demand from former homeowners who lost properties to foreclosure and others.

Many contend, too, that the building is part of a generational shift away from owning.

Developers will start construction on 260,000 units nationwide this year, about 20,000 more units than are typically started during nonrecession years, said Ron Witten, owner of apartment consultant Witten Advisors, in Dallas.

At the same time, rent growth is flagging in some parts of the country, including in the Washington, D.C., area.

But construction continues at a hasty pace in high-growth areas such as Austin, Texas, Dallas, Seattle and Denver.

In Denver, 12,700 units are under construction and 19,200 more units are in various planning stages, said Eric Karnes, director of market research for appraiser James Real Estate Services.

"My concern is that there are a lot of people tracking demand," Karnes said, "but not so many tracking supply."

Abundant financing is but one driver of the construction boom.

Fannie Mae, for instance, has financed $20.4 billion in multifamily loans through the end of August, a year-over-year increase of $500 million.

"The continuing supply of financing dollars provided by Fannie and Freddie has created strong liquidity in the marketplace for apartment buyers and developers," said Clay Sublett, a senior vice president in KeyBank Real Estate Capital's Kansas City office.

Multifamily experts note that the construction wave follows years of scant building, and thus far absorption of new inventory has been better than anticipated, Witten acknowledges.

He credits a confluence of demand, the "Millennial generation" hitting the prime renter ages of 20 to 34, empty nesters looking to simplify their lives and strict mortgage underwriting and rising interest rates that have helped fuel a preference for renting.

Developers built apartments at about the same clip in the 1990s, he noted for comparison, and they did it without the strong demographics present today.

"We have a more important source of demand now than we did then, and it's still challenging to qualify for a home loan," Witten said.

Observers also suggest that market dynamics could help temper construction. While KeyBank remains bullish on apartments, it is beginning to look for other lending opportunities, Sublett said.

Likewise, equity isn't as plentiful because sponsors are shifting their focus away from apartments as other property segments recover.

Apartment developers moving forward, however, ultimately could realize that young renter demand is shallower than they anticipated. The Pew Research Center recently said that 36 percent of 18- to 31-year-olds lived with their parents in 2012, according to its analysis of Census Bureau data.

Still, some developers have discovered another source of demand. Doran Companies, based in Bloomington, Minn., rented to a number of baby boomers even before its 180-unit luxury apartment project opened in June near downtown Minneapolis.

So now, he's building a greater percentage of more expansive two- and three-bedroom apartments in the project's 158-unit second phase.

"Empty nesters don't want to own anymore, don't want to deal with repairs and don't want to deal with financing or condo boards; they just want to pay the rent," said Doran founder Kelly Doran. "So it's not about price, it's about a lifestyle decision."